Morgan Stanley: The market's "red sea panic" has been excessive, and freight rates have been overadjusted.

On January 31st, Morgan Stanley released its latest report stating that container freight rates on the Asia-Europe route have surged by 236% due to shipping companies bypassing the Cape of Good Hope in southern Africa. However, the market's reaction to the "Red Sea Panic" has been excessive, and it is predicted that freight rates will soon decline.

Here are the key points of the report:

1. The Suez Canal is a crucial waterway for global trade, especially for container trade. According to Morgan Stanley's analysis, 12% of global trade and 30% of container trade pass through the Suez Canal. Due to the disruption in the Suez Canal and shipping companies bypassing the Cape of Good Hope, container freight rates on the Asia-Europe route have surged by 236%. The market's reaction to the "Red Sea Panic" has been excessive, and it is predicted that freight rates will soon decline.

2. In terms of stocks, the decline in freight rates will reduce shipping costs, which is expected to improve the profitability of European consumer stocks (which rely on imported goods) that have previously suffered heavy losses. Their stock prices are expected to rebound. Global shipping stocks may already be overvalued, and analysts are cautious about them and have downgraded individual stock ratings.

3. In terms of the economy, considering that the supply and demand balance of global trade goods is much better than in 2021 and that price levels are still higher than before the pandemic, the impact of supply chain disruptions on inflation is limited, and it is unlikely to cause severe inflation fluctuations.

4. If the Red Sea crisis worsens (such as rising shipping costs or prolonged supply chain disruptions), it will have a significant impact on Europe's refining industry, causing oil prices to rise, and inflation may further heat up.

Freight Rates Showing a Declining Trend

Morgan Stanley predicts that despite the current transportation disruptions providing some support to freight rates, the current rates are already over-adjusted and are expected to show a downward trend in the future (the report did not predict the duration of the shipping disruptions). This prediction is based on several reasons:

1. Container oversupply: It is expected that new container supply will increase by 8% by 2024, which is twice the rate of demand growth. Oversupply usually leads to a decline in freight rates.

2. The increase in freight rates far exceeds transportation costs: Spot container freight rates have increased by 236% compared to the same period last year, while transportation costs have only increased by about 30%. This disconnect indicates that the increase in freight rates has exceeded the reasonable range of cost growth.

1. Container ship daily charter rates only increased by 17%: Shipowners own the vessels, while operators lease the vessels from shipowners to provide transportation services to cargo owners for profit.

The daily charter rates for container ships (i.e., the daily rental fees agreed upon between shipowners and operators for the use of container ships) only increased by 17%. Compared to the significant increase in spot freight rates for containers, the increase in daily charter rates is relatively small. From a medium-term perspective, this reflects the expectation of shipowners and operators that the impact of these disruptions on long-term supply and demand balance will be relatively mild, and the increase in rental costs will not be as significant as spot freight rates.

1. Price competition begins: Freight prices on the Asia-Europe route have been declining for two consecutive weeks, which is seen by Morgan Stanley as a sign of price competition emerging in the market. In the shipping industry, companies often prioritize expanding or maintaining market share rather than immediately pursuing high profits, and there will be more price reductions in the future.

2. Terminal retail customers choose to wait before signing contracts: Retail customers are likely to have taken into account the above four factors and anticipate a downward trend in future freight rates, so they choose to wait for more favorable contract conditions.

3. Container shipping volume through the Suez Canal has significantly decreased: Due to the transportation disruption, the container shipping volume through the Suez Canal has decreased by 80% YoY, and the supply risk from the Suez Canal seems to be limited.

Global shipping stocks and European consumer stocks will undergo a shift

In terms of stocks, the decline in freight rates will reduce shipping costs and may have an impact on global shipping stocks and European consumer stocks that rely on imported goods:

The short-term impact of the transportation disruption in the Red Sea region on global container shipping stocks and certain European retail stocks may have reached its peak and is beginning to show signs of relief. However, this impact will not be evenly distributed among all stocks, but rather tends to favor specific individual stocks or sectors.

1) Previously, supply chain disruptions led to the highest increase in stock prices of global container shipping stocks. However, analysts believe that these stocks are now "overvalued" and the market has overreacted to the Red Sea transportation disruption. Analysts are cautious about "global container shipping stocks" and have given "sell" ratings to 5 out of the selected 10 stocks with the highest increase, and a "hold" rating to 1 stock.

Transportation and logistics stocks have seen the largest increase due to the Red Sea crisis.

2) Previously, supply chain disruptions led to the largest decline in stock prices of non-essential European retailers and essential consumer goods stocks. Currently, analysts believe that with the decline in freight rates, the cost pressure on these companies will ease and their profit prospects will improve, leading to a certain degree of rebound in stock prices of such companies. Analysts have upgraded two stocks to "buy" due to the impact of the Red Sea crisis on the consumer/non-essential retail sector, which experienced the largest decline.

The analysts also assessed the impact on various sectors such as European aviation, automotive, capital goods, metals and mining, chemicals, and diversified financial services. Although each industry has been affected differently, overall, the supply chain disruptions have not reached the severity seen in the early stages of the COVID-19 pandemic.

Furthermore, the supply chain disruptions will prompt some long-term industrial and supply chain adjustments. For example, approximately 60% to 80% of steel imports come from Asia and are transported to Europe through the Red Sea. The supply chain disruptions have resulted in higher costs and longer delivery times for downstream users. This may encourage more companies to consider "reshoring" production to increase the capacity utilization of domestic steel mills. This shift can not only reduce dependence on imported steel but also enhance the competitiveness of local production, although it may lead to short-term cost increases.

Limited Impact of Transportation Disruptions on Inflation

From an economic perspective, Goldman Sachs believes that although supply chain disruptions may push up prices, the impact is limited and unlikely to trigger significant inflationary fluctuations:

Given that the prices of global trade commodities are already relatively high compared to pre-pandemic levels, and the current global trade commodity supply-demand balance is more balanced than in 2021, this helps to suppress inflationary pressures.

By quantifying the relationship between extended supplier delivery times and inflation, analysts estimate that the extension of supplier delivery times may lead to an increase in inflation of approximately 0.1% in the eurozone and 0.15% in the UK. This data is considered as the upper limit of inflation, and even in the event of supply chain disruptions, the magnitude of inflationary increase is unlikely to exceed these estimates. Currently, only the risk of future inflationary pressures caused by longer-term transportation disruptions needs to be considered.

Greater Impact on European Refineries if the Red Sea Crisis Intensifies

Goldman Sachs believes that if the Red Sea crisis intensifies, such as prolonged supply chain disruptions, it will have a significant impact on the European refining industry and lead to an increase in oil prices:

Firstly, European refineries rely on imported crude oil and petroleum products from the Middle East and Asia to produce finished oil products. The Suez Canal is a key route connecting these regions to the European market. If this route is severely affected, the cost and time for refineries to obtain raw materials will increase, thereby affecting their production efficiency and profitability. In the event of transportation disruptions, different types of cargo are affected to varying degrees. So far, crude oil transportation has been less directly affected compared to container transportation. However, the need for rerouting cargo has increased the "ton-mile demand" for crude oil transportation, meaning that the same amount of crude oil needs to be transported over longer distances, thereby increasing transportation costs.

Secondly, the transportation of refined oil products, such as diesel or gasoline, has been significantly impacted, with freight rates reaching their highest levels in a decade. This increase in freight rates is unfavorable for Europe as it raises the cost of importing refined oil products, putting pressure on the economy and consumers.

Europe imports approximately 1 million barrels per day of middle distillates (such as diesel and aviation kerosene) from refineries east of the Suez Canal. Due to the rise in transportation costs, Europe may need to increase the selling price of these oil products. This way, even in the face of higher import costs, refineries are still willing to import these oil products as they can maintain their profit margins by raising the selling price.

The transportation of the Suez Canal is particularly important for the European refining industry, especially for the supply of middle distillates and fuel oil.